Question

You have been asked to evaluate the economic impact of each policy proposal, which are:

1. Add a carbon tax of $0.05 per kilowatt hour of usage on consumers.

2. Set a price floor for the cost of electricity to $0.23 per kilowatt hour of usage.

3. Do nothing.

For each, policy option please find:

1. The change in total quantity of electricity purchased by consumers.

2. The change in consumer surplus.

3. The change in producer surplus.

4. Revenue from the policy, if any.

5. The net welfare gained or lost for the economy as a whole.

6. The political benefits or repercussions of the policy, and the impact on the power company and the people of Greenish.

To carry out this analysis, you have been given the following information about the current electricity market in the City of Greenish for electricity consumption/production per month. The quantity of electricity is in millions of kilowatt hours (or how electricity production and consumption is measured), so multiply your quantity by 1,000,000 when calculating total quantity, CS, PS, and net welfare gained or loss. Pd = -0.22Qd + 1 Ps = 0.03Qs To simplify your calculations, you may assume that all supply and demand curves for electricity markets in Greenish are linear.

Begin by drawing a graph to illustrate each of the scenarios. The graphs will help you identify which areas you need to find. • To do this, you also need to calculate prices, quantity, and consumer and producer surplus in equilibrium. That is your baseline. • Since Q is in 1,000,000 kWh, do not forget to multiply your final Q (e.g. equilibrium Q sold) by 1,000,000. This will carry through the CS and PS calculations as well (i.e. the base of your triangle will be Q in terms of 1,000,000 kWh).

Answer 1

Consider the given problem here the demand and the supply of electricity are given below.

=> Pd = 1 - 0.22*Q, and Ps = 0.03*Q. So, at the equilibrium the demand must be equal to supply.

=> Pd = Ps, => 1 - 0.22*Q = 0.03*Q, => Q = 1/0.25 = 4, => the market price is “P = 0.12”. So, the initial equilibrium price and the quantity are “P1 = 0.12” and “Q1 = 4,000,000”. Consider the following shows the equilibrium price and quantity of electricity.

Here the CS is given by the area “A1P1E1 = 0.5*(1-0.12)*4*1,000,000 = $1,760,000.

Here the PS is given by the area “A2P1E1 = 0.5*(0.12)*4*1,000,000 = $240,000.

1).

If the a tax of “0.05” is imposed on buyer, => the new demand is given by, => Pd = 1-0.05 – 0.22*Q, => Pd = 0.95-0.22*Q, and the supply will remain as before, => at the equilibrium the demand must be equal to supply.

=> 0.95 – 0.22*Q = 0.03*Q, => Q2 = 3.8, => P2 = 0.114. So, the equilibrium quantity and the price paid by buyer and received by seller are given by, => Pb=0.144+0.05=0.164, Ps=0.114 and Q2 = 3,800,000.

So, here the change in quantity is “Q2-Q1 = 3,800,000 – 4,000,000 = (-200,000) < 0. So, the quantity demanded decreases.

2).

Now, the new CS is given by the area “A1PdC1 = 0.5*(1-0.164)*3.8*1,000,000 = $1,588,400”. So, the change in CS is given by “$1,588,400 – $1,760,000 = (- $171,600)” < 0. So, the CS decreases.

3).

Now, the new PS is given by the area “A2PsC2 = 0.5*(0.114)*3.8*1,000,000 = $216,600”. So, the change in PS is given by “$216,600 – $240,000 = (- $23,400)” < 0. So, the PS decreases.

4).

Here the tax revenue is given by, => t*Q2 = 0.05*3.8*1,000,000 = $190,000.

5).

The change in welfare is the sum of change in CS and PS, => change in Welfare = (-$171,600) + (-$23,400) = (-$195,000) < 0. So overall the welfare decreases.